The gathering storm

«We are being dielionest by definition atul [we are] ul risk of damaqittq reputation in the market and with the regulators."

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Thus wrote one Barclays banker, on December 42007, to "manager E", according to regulatory documents published this week by the UK Financial Services Authority. Five years on it is clear that the subject of those prophetic words - the price-manipulation scandal in the interbank lending market whose vast scale was unveiled by regulators this week - has done a lot more than just reputational damage. Barclays has paid a record £290m in combined fines to settle investigations by the FSA,the US Department of Justice and the Commodity Futures Trading Commission (CFTC),the US futures regulator. Now the scandal threatens to unseat the bank's top management, with some shareholders, commentators and politicians calling for the head of Bob Diamond, chief

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executive; David Cameron has gone almost as far. "People have to ta ke responsibil ity for their actions and show how they are going to be accountable for those actions," the UK prime minister said on Thursday. On top of the wrongs of the scandal involving the manipulation of the London Interbank Offered Rate (Libor) - a central financial reference point for everything from the rates charged to credit card users to the pricing of commercial loans - in the eyes of many politicians and much of the general public Mr Diamond carries a stigma: he is a banker. Across much of the western world, bankers have acquired pariah status since the financial crisis began in 2007 - blamed for helping to cause it, and for continuing to pay themselves a fortune, even when governments have bailed them out and shareholders have seen their investments plummet. Compounding that has been a succession of consumer mis-selling scandals, one of the latest and largest of which in the UK has forced banks into a forecast £6bn of compensation payouts over miss old payment protection insurance (PPO. A recent massive IT failure at the largely state-owned:r3::?Y<::1}l.:?<::l!1:~?~~';:'?~!<::l!1:?:group that saw customers unable to conduct basic banking business has only added to public questions about competence in the sector. As such the prime minister's words were a pithy expression of the mounting fury among pol iticians over the excesses of what remains one of the UK't:;bigget:;L induatries, but also one that is increasingly as yet - to bring it to heel. scorned by the public and which policy makers have -

The Libor affair adds a powerful dimension to the reputational disaster enveloping the banking sector - with the potential to eject bank bosses around the world and harden regulators' resolve to pile yet tougher rules on an already beleaguered sector.

Though it sounds more abstruse than other recent scandals, Libor has a very real-world impact, underpinning the terms of $350tn of borrowing contracts worldwide. Libor rates are set by a panel of banks on the basis of what they disclose to be their average cost of interbank borrowing. But as the documents divulged by regulators in the Barclays settlement suggest, the process was abused by a number of those groups systematically and over a period of many years, both before and during the crisis.

Lord Turner, chair of the FSA, says "we would be fooling ourselves" to assume the alleged malpractice in Libor were not current in other types of trading. "There is a degree of cynicism and greed which is really quite shocking ...and that does suggest that

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there are some very wide cultural issues that need to he strongly addressed." In Barclays' case, the first to be fully documented by regulators, the evidence shows it hroke rules barring different parts of the han k from speaking to each other and at the same time lied in its submissions to the rate-setting process. Before the crisis, traders sought to manipulate Libor rates to help make a profit. And in the teeth of the crisis in late 2007 and early 2008, under the encouragement of mid-level management, the bank deliberately underreported the rates it could borrow at in order to calm jittery investors. "[Manager E]'s asked me to put it lower than it was yesterday ...to send the message that we're not in the shit," one person involved in submitting its borrowing rates to the Libor panel said in an email at the time. The Libor scandal still has some lime lo run, with other banks expected lo be fined. Barclays is the first to suffer big fines but UBS and Citigroup have both been disciplined in Japan and the likes of HSBC, Royal Bank of Canada and RBS have been mentioned in court documents. Critics say Libor was a case of market manipulation just waiting to happen. As in many areas of the markets for bonds, derivatives and commodities, indices are often drawn up on the basis of the prices submitted by banks and dealers. This contrasts with equity derivatives, which are priced with reference to how shares trade on public stock markets. Because there is no equivalent to a stock market for many bonds, and derivatives, price-setting is more opaque - and open to abuse. Such indices are vital in derivatives markets because trillions of dollars in swaps and futures contracts are traded on the basis of these prices, setting the level of products such as mortgages and savings accounts. That gives traders a heavy incentive to distort prices in their own favour. "The problem is, if you don't have a central market where prices are set, how do you get them?" says Craig Pirrong, a professor at the University of Houston. "When there is big money at stake, the mechanisms tend to get very brittle." Libor is not the first price-manipulation affair in banking but it is one of the most serious, recalling the Treasury bond scandal at Salomon Brothers in 1991 that imperilled Salomon, now a part of Citigroup. Its chief executive, John Gutfreund resign after Paul Mozer, a bond trader, submitted false bids in the T-bill market. had to

A similar scandal erupted in the US natural gas market in 2002 when the CFrC fined a number of companies. One of them was found to have kept a spreadsheet of prices

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labelled "bogus", as the real ones. In a recent speech Scott O'Malia, a CFrC commissioner recalled the energy sector as "the wild wild west" in which "no one quite knew who was l.he sheriff and who was l.he outlaw." More recently questions have been raised about the market for dollar swaps derivatives linked to government bond yields - with prices set every day at i.iam in New York. As in the case of Libor, the pricing process is dominated by a handful of banks. Similarly, price-selling in the oil market, which is carried oul by news organisations such as Platts, has been under scrutiny. Iosco, an international regulatory group, has warned of the risk of the benchmark being "manipulated by the submission of false prices". The detailed revelations of the Libor scandal will further strengthen the muscle of regulators in their tussle with banks over how much of the derivatives market should he forced on to exchanges or cleared centrally in order to ensure price transparency. Provisions to reform these markets were part of the Dodd- Prank Act passed by the US Congress following the 2008 financial crisis. However, the CFfC has faced heavy resistance from banks over its implementation. The affair will add more broadly to the fallout from the recent trading scandal at .JPMorgan, where the hank has so far lost an estimated $5hn on mismatched hedging positions, sharpening regulators' focus on supervising banks more closely and forcing them to be more transparent. That drive will be all the stronger because of the breadth of the Libor investigations, with regulators from Europe to the US to Japan collaborating to probe close to 20 banks. For Barclays, though, the resonance is particularly strong - and understandably so. The bank has been hit with a string of regulatory and tax investigations on both sides of the Atlantic. It has been fined in the UK for misreporting trading transactions and providing poor advice, and in the US for breaching sanctions on the financing of repressive regimes. Earlier this year the UK government stepped in to block Barclays from implementing two "highly abusive" tax schemes that could have cost the Treasury £50om, adding to long-running questions about its tax structuring. And then there is the controversy around Mr Diamond himself. At a recent annual

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shareholder meeting a third of shareholders voted against last year's pay report, after it emerged that Mr Diamond had received close to £25m in total remuneration, including a conLroversial "Lax eq ualisation" paymenL of nearly £6m. Amid all the torrid news of recent months, Mr Diamond has continued to stress his insistence that Barclays cares about "citizenship" - a claim critics say sounds ever more hollow. Within the past 48 hours he repeated his mantra in a letter to Andrew Tyrie, head of the House of Commons' treasury select committee, the body Lowhich he will have Lo explain himself in the coming days or weeks. "I am determined that Barclays plays its role as a full corporate citizen, acting properly and fairly always, and contributing positively to society in everything that we do," Mr Diamond wrote. Whether he will be the man to see that mission through depends now on an increasingly anxious shareholder base - amid catcalls from an increasingly critical government - being prepared to give him another chance. 1t is more than three years since Fred Goodwin was removed as RBS chief executive and less than one since Mr Diamond told Mr Tyrie's committee that "the period of remorse and apology" by banks was over. The events of recent days have put a question mark over that claim. He has had to issue a public apology and is facing another grilling from the committee. Mr Diamond has said he does not intend to resign. But if he is forced to go it will send yet another shot across the bows of all bank bosses, especially those at other institutions implicated in the Libor scandal. Such a scenario might assuage an angry public. Whether it addresses the underlying problem is questionable. Sir Mervyn King, governor of the Bank of England, has called for "a real change in the culture" of banking which he said had to go beyond issues of personnel. "There's no point in thinking if one or two people disappear, you've solved the problem," he said yesterday. "If the structure along and behave the same way." remains the same, other people will come